Irish High Steet spending: some volume growth, boosted by falling prices

The volume of Irish retail sales excluding the motor trade peaked in December 2007 and fell by almost 15% over the following four years , recovering marginally in 2012 before making a double bottom early last year ( using  a 3-month average to reduce some of the volatility in the CSO data). Since then the volume of spending has picked up somewhat, rising by 5.2% from the low,  with the annual increase in August at 3.7% .Still a long way from the peak, therefore, but at least there is some signs that consumers have returned to the High Street.Total retail sales are up 6.8% in volume terms, thanks to strong car sales, and overall consumer spending has  also shown some growth, albeit at a slower pace (spending was up an annual 1.8% in the second quarter) implying that spending on services has yet to show the same forward momentum.

The upturn in  High Street sales is widespread, with most areas seeing some increase in volumes over the past year. The most pronounced is in Furniture and Lighting, up an annual 20.7% , no doubt reflecting the pick up in housing transactions and completions, followed by Electrical goods with an 11.6% gain. The volume of spending on Footwear and Clothing is also recording strong growth( 5.4%)  as is Motor Fuel (4.4%), which is not surprising given the surge in car sales this year (an increase of 24% according to the retail data). Spending on Food tends to be less volatile than most other areas and that too has seen growth, with the volume of sales up 3.2%, although spending on beverages and tobacco is down.

Spending in volume terms is  also falling in some other areas, including Pharmaceuticals and Cosmetics (-0.8%), Newspapers and Books (-1.6%) while in Bars the figure is -2.7%. It is not clear that the  latter has yet bottomed, with the volume of sales down over 37% from the peak , while the fall in the volume of Newspaper and Book sales is even starker, at over 47%, although there has been some modest growth in the past few months.

Some good news then for at least some areas of the High Street, although a closer look at the data reveals that the growth in actual spending is not as pronounced, with price falls still evident in most sectors. The price of Electrical goods is down by over 5%, for example, so reducing the increase in the value of spending to 5.8% despite a volume increase of 11.8%, with Furniture and Lighting also seeing a pronounced price fall, this time of 3.6%. A few sectors have attempted to raise prices, including Newspapers and Bars but the total  price deflator for retail sales ex autos fell by 1.7%, so reducing the rise in the value of sales to 2% despite a volume increase of 3.7%. The pace of price decline has eased a little over recent months, from -2% earlier in the year, but it is clear that although conditions for High Street businesses are indeed improving, the volume figures give a more upbeat trend than  experienced by many retailers.

 

Irish GDP surges, impressing the Government but not consumers

Ireland’s quarterly GDP figures are volatile and often surprise, with the latest no exception; the economy grew by a seasonally adjusted 1.5% in q2, following a 2.8% expansion in the first quarter, the latter revised up marginally from the initial release. That surge in Irish output left the annual growth in real GDP in q2 at an extraordinary 7.7% and means that in the absence of revisions the average growth rate for 2014 as a whole would average 5% even if GDP was to remain flat in the second half of the year. The consensus growth forecast has moved steadily higher as the year  has unfolded , from an initial 2% to around 3%, but this latest data will no doubt prompt a further substantial upgrade- the Finance Minister has already mentioned 4.5% and that requires a fall over the second half of the year. Some commentators prefer GNP as a better measure of economic activity in Ireland (it adjusts for net  external flows of profits, interest and dividends) but that tells a similar story-indeed, the annual GNP  growth rate in q2 was 9%, although base effects in the second half may mean that the annual  GNP growth rate in 2014 will also be around 5%.

The monthly external trade data had implied a strong  merchandise export performance in q2 (the Patent Cliff impact on chemicals appears to be over, at least for now) but the national accounts included  even stronger figures,  which alongside a better performance from service exports resulted in a 13% annual increase in export volume. Import growth was also very strong, at 11.8%, but such is the dominance of exports (now 117% of GDP)  that annual GDP growth would have been 4% even if the other components made no contribution.

In the event they all contributed. Investment rose by 18.5% on the year, adding 2.5 percentage points to GDP growth, following strong gains in construction output and spending on machinery and equipment. Government spending  also rose , and by a puzzling 7.9% in volume terms, which sits uneasily with the idea of spending cuts and fiscal austerity and may reflect problems with the price deflator. The third component of domestic  demand, personal consumption, also rose, but by a modest 1.8%, and even that was flattered by base effects from last year as the quarterly increase in q2  this year was just 0.3% following a meagre 0.2% rise in q1. It is clear from other data sources that Irish households are still  paying down debt at a steady clip and it is impossible to say when this deleveraging will end. Employment growth has also slowed sharply in 2014 and in the absence of a marked change in household  behaviour personal consumption growth in 2014 is likely to be nearer to 1% than the 2% many expected.

Such is the volatility  and unpredictability of exports and investment that real GDP  growth in 2014  could be over 6% or nearer 4%, but we currently expect  5%.Export prices are falling, as is the deflator of government spending, and for that reason the rise in nominal GDP this year may be less than that recorded for real GDP – we expect 4%.That would give a nominal GDP figure  in 2014 of €182bn but still substantially above the €171bn forecast in the 2014 Budget. Tax receipts are also  running well ahead of target and so we now expect the General Government deficit for the year to emerge at 3.4% of GDP compared with the 4.9% originally forecast by the Government. The implication is that a fiscal adjustment of the order of €2bn in 2015, as originally envisaged and still advocated by the Fiscal Advisory Council (although the Council’s latest paper did  not take account of the q2 GDP figures), would probably push the deficit well below 2% of GDP and therefore comfortably under  the 3% target set by the Excessive Deficit procedure. The  strength of tax receipts had moved the Government towards a much smaller adjustment in any case  but the latest GDP figures appear to have convinced them to abandon austerity and at worse go for a neutral budget, with tax cuts funded by higher taxes elsewhere, mainly the Water Charge.

Early repayment of Ireland’s IMF debt

The Irish Government is exploring he possibility of  early repayment of the monies borrowed from the IMF and below we examine the issue.

How much does Ireland owe the IMF?

Ireland  arranged to borrow €22.5bn from the IMF as part of the bailout deal agreed with the Troika, although the fund actually lends in Special Drawing Rights (SDR’s) , the IMF’s unit of account, which is constructed as a basket of four currencies (the US dollar,  euro, Yen and Sterling) with the dollar having the largest weight followed by the single currency. Ireland drew down SDR19.47bn from early 2011 through to late 2013 and the loans have maturities ranging from 4.5 years to 10 years, with an average maturity of 7.3 years. The SDR ‘s value against the euro changes daily and at the time of writing buys €1.16 so Ireland currently owes 22,6bn in euro terms, although the loan has to be repaid in SDR’s. In that sense Ireland can be said to have borrowed from the IMF in four currencies.

What is the interest rate on the loans?

Ireland has borrowed from the IMF under the Extended Fund Facility and the rate charged is floating, depending on the 3-month SDR rate ( itself a weighted basket of rates in the four constituent currencies) and a surcharge. The SDR rate is currently only 0.05% (the euro and yen rates are actually negative) so the premium is much more significant. That depends on how much one borrows relative to ones contribution to the fund , or quota, which is determined by GDP, population and other economic criteria. Ireland’s quota is SDR1.258bn and a country can borrow up to 3 times that (or SDR3.77bn in this case ) at a 1% surcharge. Anything beyond that carries a 3% surcharge , rising to 4% if the loan term extends beyond three years

So how much is Ireland paying?

If we assume the loan term will average 7.5 years Ireland would pay 1.05% per annum on the first SDR3.77bn and on the remaining SDR15.7bn 3.05% over the first three years and 4.05% on the final 4.5 years. This gives an average blended rate of 3.15%. In fact the loan  also carried a one-off 0.5% charge so averaging that out over the term  and adding it to the cost gives an annual rate of 3.21%. This is an SDR rate of course and Ireland raises taxes in euros, so the NTMA will use the swap market to convert euros in to the appropriate basket of currencies. Consequently the NTMA quotes an average euro rate for the loan based on a 7.5 year maturity swap, and that was put at just under 5% in March of this year, implying an annual interest payment in euros of over €1bn on the IMF loan. Ireland’s total interest bill on all outstanding debt  this year is just over €8bn.

How much is Ireland paying in the market?

Bond yields have collapsed across the euro zone on the expectation that short term rates will stay low for a very long time and, probably, in anticipation of bond purchases by the ECB. Irish yields have fallen precipitously too, with a government bond maturing in 10 years currently trading at 1.85%, with shorter maturities at much lower  yield levels. It would therefore appears that Ireland could borrow much more cheaply in the market than the current cost of the IMF loan  and it would make sense to borrow at a longer maturity given the low level of current yields..  The Minister for Finance has mentioned a figure of €18bn for repayment and yields would presumably rise if Ireland announced a much heavier issuance schedule  than currently planned ( only €10bn was slated for this year in total) but even at ,say 3.0% for a 20 year bond , the saving would be around €360mn a year , not counting any additional costs involved in breaking the swaps.

What’s the problem then?

There are two issues. One is that the other members of  the Troika need to sign off on early repayment, which brings in EU Governments  and in some cases parliaments. The second is the Promissory note deal, which involved the Irish government issuing  €25bn in long term bonds to the Irish Central bank . The ECB was never happy with the transaction, believing it to be ‘monetary financing’, and insisted that the Central bank sell the debt into the market over time. The schedule for the latter is light, with sales of €0.5bn a year out to 2018 before rising to €1bn a year, but Draghi now appears to be linking any ECB support for early IMF debt repayment with a more rapid sale by the Central bank.

Does the Prom deal matter that much?

The Irish Government  borrowed the €25bn from the Central Bank , which in turn borrowed from the ECB, and  the Government pays  a floating rate coupon of 6-month euribor ( currently 0.2%) plus 262 basis points on the bonds , implying an annual interest payment of €700mn. That  means a  large profit for the Central bank as its borrowing cost is now virtually zero, and most of this profit is transferred to  the exchequer. If ,say, the Central bank sold €5bn into private sector hands that circular flow of income would be broken, costing the exchequer, with interest payments now leaking out into the investors who bought the bonds from the Central bank while the latter would use the proceeds  of the sale to repay the ECB.

So the ECB’s call is key?

The ECB’s view is therefore very significant, as a much more rapid sale of bonds by the Central bank, in return for a nod on the IMF repayment,  would reduce the benefit of  the latter, by driving up Irish yields and  via a reduction in Central bank and therefore exchequer income. It is an irony though, and one that may well be pointed out by the Irish authorities, that Draghi is now  keen for the  ECB  to  eventually embark on full scale bond purchases across the euro area, which some might view as ‘monetary financing’ too, although no doubt Frankfurt will argue that the cases are different.

 

Irish household wealth is rising but debt repayment ongoing

Mario Draghi may be doing his best to encourage European consumers to borrow and spend but the evidence in Ireland still points to ongoing deleveraging, despite rising household wealth. The debt burden is now falling steadily, however, in contrast to the situation over recent years, but is still extremely high by international standards and it is anyone’s guess when the deleveraging process will come to a close.

The Irish Central bank publishes financial accounts data which tracks each sector’s assets and liabilities and the figures for the first quarter have just been released. Loans to households fell by €1.9bn in q1, bringing the total decline since the peak in mid-2008 to over €39bn. That deleveraging has dwarfed any new lending, which explains why the outstanding amount of personal credit is still falling despite a pick up in new loans. The absolute debt figure is now back to the level last seen in mid-2006.

Of more significance is the debt burden, which is generally expressed relative to disposable income. On that metric the burden peaked at 218% in late 2009 but did not fall materially for some time after that despite deleveraging because household income, the denominator, was also falling, reflecting rising unemployment, falling wages and an increase in the tax burden. Income finally stabilized  in 2012, ( although it is still volatile even on the four quarter total used by the Central Bank ) and has started to inch higher, so the debt ratio has started to fall at a steady clip, declining to 182% in the first quarter of 2014 from 185% in the previous quarter and 198% a year earlier. The household debt burden is now also back at 2006 levels, although a long way above the 133% recorded a decade ago.

Households are reducing their liabilities but their financial assets are climbing, and indeed have been rising for the past five years, largely reflecting growth in the value of assets held in pension and insurance funds. Household’s financial assets amounted to €339bn in q1, leaving net financial worth of €165bn, a record, and some €100bn above that recorded at the nadir of the financial crash.

Most Irish household wealth is in the form of housing, however, and when that is added we arrive at a  total net worth figure of €509bn. The housing component actually fell in the quarter ( national house prices declined in q1) and wealth  is still some €200bn below the peak but it has recovered by €50bn over the past year.

House prices rose again in q2 so that alongside the pick up in house building ( up an annual 37% in h1) will have boosted wealth  in recent months. The data on bank lending implies that debt repayment has remained a feature as well so the net household wealth figure will probably record a further rise in q2. Rising wealth is generally seen as positive for consumer spending but we have never seen the pace of deleveraging evident in Ireland of late (households have been net lenders rather than borrowers for over five years now) and we do not know how long that will continue to dampen personal consumption.